In: Accounting
Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $37 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:
Per Unit | 23,000 Units Per Year |
|||||
Direct materials | $ | 16 | $ | 368,000 | ||
Direct labor | 9 | 207,000 | ||||
Variable manufacturing overhead | 4 | 92,000 | ||||
Fixed manufacturing overhead, traceable | 6 | * | 138,000 | |||
Fixed manufacturing overhead, allocated | 9 | 207,000 | ||||
Total cost | $ | 44 | $ | 1,012,000 | ||
*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).
Required:
1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier?
2. Should the outside supplier’s offer be accepted?
3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $230,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier?
4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?
per unit | |||||||||
Differential cost | 23,000 | units | |||||||
make | buy | make | Buy | ||||||
Cost of purchasing | 37 | 851000 | |||||||
Direct materials | 16 | 368000 | |||||||
direct labor | 9 | 207000 | |||||||
variable manufacturing overhead | 4 | 92000 | |||||||
fixed manufacturing overhead ,traceable | 2 | 46000 | |||||||
fixed manufacturing overhead,common | 0 | 0 | |||||||
total costs | 31 | 37 | 713000 | 851000 | |||||
Difference in favor of continuing to make the carburetors | 6 | 138000 | |||||||
Make | Buy | ||||||||
1a) | total relevant cost (23,000 units) | 713000 | 851000 | ||||||
financial disadvantage | 138,000 | answer | |||||||
1b) | Reject | ||||||||
2a) | make | Buy | |||||||
cost of purchasing (part1) | 851000 | ||||||||
cost of making (part 1) | 713000 | ||||||||
opportunity cost- segment margin forgone | 230,000 | ||||||||
total cost | 943000 | 851000 | |||||||
difference in favour of purchasing from outside supplier | 92000 | ||||||||
Make | Buy | ||||||||
total relevant cost (23,000 units) | 943000 | 851000 | |||||||
financial advantage | 92,000 | ||||||||
2b) | Accept | ||||||||